Question 3 (b)

Effects of changes in sales and EBIT through the leverages

9 marks

Time to write
About 18 minutes
Topic
Leverage and EBIT-EPS analysis

Question

Question 3 (b) · 9 marks

Sundaram Company Pvt Ltd provides the following data:

Particulars Rs.

• Sales: 4,80,000

• Less: Variable cost (40%): 1,92,000

• Contribution: 2,88,000

• Less: Fixed cost: 1,92,000

• EBIT: 96,000

• Less: Interest: 24,000

• EBT (Earnings Before Tax): 72,000

Find out:

  1. If EBIT increases by 6%, by what percentage will the EPS increase?

  2. If sales decrease by 10%, by what percentage will EBIT decrease?

  3. If sales increase by 15%, by what percentage will the EPS increase?

Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

18 minfor 9 marks

Read from the question

  • What…?3 questions in all: answer every one.
  • Find outFormula first, then the working, then the answer with its unit (₹, %, units).

Write it in this order

  1. Read the data; note exactly what is asked 1 min
  2. 1 Degrees of leverage 3 marks 5 min
  3. 2 (i) EPS change 2 marks 4 min
  4. 3 (ii) EBIT change 2 marks 4 min
  5. 4 (iii) EPS change 2 marks 3 min
  6. Check: arithmetic, units (₹, %), final answer underlined 1 min

Try it first. About 18 minutes for 9 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Degrees of leverage

  • DOL = contribution ÷ EBIT = 2,88,000 ÷ 96,000 = 3.
  • DFL = EBIT ÷ EBT = 96,000 ÷ 72,000 = 1.3333. (No tax rate or preference shares are given; with a constant tax rate and number of shares, EPS changes in the same proportion as EBT.)
  • DCL = DOL × DFL = contribution ÷ EBT = 2,88,000 ÷ 72,000 = 4.

Each degree gives the % change in one figure for a 1% change in another.

Each predicted change can be verified by recomputing the statement at the changed level.

(i) EBIT up 6%: EPS rises by DFL × 6% = 1.3333 × 6% = 8%. Check: EBIT 1,01,760 − interest 24,000 = EBT 77,760, which is 8% above 72,000.

(ii) Sales down 10%: EBIT falls by DOL × 10% = 3 × 10% = 30%. Check: contribution 2,59,200 − fixed cost 1,92,000 = EBIT 67,200, which is 30% below 96,000.

(iii) Sales up 15%: EPS rises by DCL × 15% = 4 × 15% = 60%. Check: contribution 3,31,200 − 1,92,000 − 24,000 = EBT 1,15,200, which is 60% above 72,000.

Where the 9 marks sit

#ComponentMarks
1Degrees of leverage3
2(i) EPS change2
3(ii) EBIT change2
4(iii) EPS change2
Total9
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